The Reserve Bank is concerned about the high Australian dollar, but taking drastic action to push it lower could do even more harm, writes Michael Janda.

The Australian dollar has become a hot topic again, with the IMF considering adding it to the list of reserve currencies, and speculation stirring about a Reserve Bank intervention.

Barring a few short dips just below 100 US cents, the Australian dollar has remained above parity for the best part of the past two years.

For the first half of that period, such strength seemed reasonable on the back of record commodity prices and terms of trade. However, those commodity prices have been easing, and in some cases slumping, over the past year, dragging Australia's terms of trade lower with them.

The Reserve Bank's index of commodity prices was down 16 per cent over the year to October, as measured in terms of a basket of international currencies.

Normally, that fall would be smaller in Australian dollar terms, as the currency would slide in response, just as it did when it dropped from 98 US cents to 60 in the space of a few months during the early stages of the global financial crisis in 2008.

However, the fall in commodity prices has actually been steeper in Australian dollar terms, because the currency has appreciated slightly over the past year.

The terms of trade have eased along with commodity prices, but what is not commonly appreciated is that when RBA governor Glenn Stevens says they remain at historically high levels, he is not exaggerating.

Back at the end of June the index was at 118.2 - it will have fallen further since then with the decline in prices for Australia's key coal and iron ore exports, but it is still around its high pre-financial crisis levels, just not at last September's record high of 130.2.

Still, with commodity prices and the terms of trade now off record levels, one would expect the Australian dollar to follow, rather than sitting only around 5 or 6 per cent off its post-float high above $US1.10.

Certainly the Reserve Bank has been expecting the local currency to ease - it has repeatedly stated the currency is somewhat higher than it expected given the falling prices for Australia's key exports.

Lately there has been speculation that the RBA may be effectively printing new money to meet the demand for Australian dollars coming from foreign central banks.

That speculation has been driven by a steep rise in the central bank's "other outright" foreign exchange transactions, increasing the bank's holdings of foreign currency.

However, it seems the far more likely explanation for the rise in Reserve Bank foreign currency holdings is not the creation of new money to actively push the Australian dollar down. Rather, it seems that the RBA is leaning against the wind so as not to add further demand for the local currency.

If the Australian dollar was at a level the Reserve Bank was more comfortable with, it may normally choose to go into the market and convert the foreign currency other central banks have left on deposit with it back into Australian dollars.

But to do so now would simply add more demand for Aussie dollars and push the currency higher still.

Instead, the bank seems to be accumulating the foreign currency to avoid putting more pressure on the dollar, and perhaps send a signal to currency traders that the uncomfortably high level of the Aussie dollar is nearing a point where it might take more active measures to lean against further rises.

It is also probably a wise investment strategy given that the RBA thinks the Aussie dollar is overvalued, as the foreign currency could be sold on the markets later when it is worth more in local dollar terms.

Central banks often turn profits for their governments, because their currency intervention follows the classic investment advice of buying low and selling high.

Eventually, if the Australian dollar does start falling, especially if it falls faster than is desirable for financial stability, the RBA would be able to use its foreign exchange reserves to help lean against that change of wind.

In the meantime, the level of the dollar and scale of damage it is doing to export-exposed industries such as manufacturing, education and tourism seems to be almost exclusively in the hands of market forces.

With the US Federal Reserve still pumping at least $US40 billion worth of fresh greenbacks into the global economy each month through QE3, and other key reserve currency central banks also effectively printing money in an attempt to revive their flagging economies, it is hard to see the Australian dollar falling far from current levels in the short-term.

This outlook is reflected in an IMF staff recommendation to include the Australian dollar in its data on the foreign exchange reserves held by central banks around the world.

While not likely to have an impact on the value of the dollar itself, it is a reflection of the growing adoption of the Australian dollar as a minor reserve currency, with foreign central bank purchases seen as a key reason for the local currency's continued strength in the face of commodity price weakness.

The Australian dollar is so popular mainly because Australian Government 10-year bonds pay at least a percentage point more in interest than the few other remaining AAA-rated sovereigns, and more than seven times the interest of Swiss bonds.

That underlying demand for safe, higher-yielding assets combined with the efforts of other countries to lower their currencies means that if the RBA wanted to engineer a fall in the Aussie dollar, it would take fairly drastic action to offset the actions of its much larger central banking counterparts - and such dramatic moves could end up doing more harm than good.

Michael Janda is the ABC's online business reporter. View his full profile here.

Comments (12)

paradise:

23 Nov 2012 2:20:29pm

We have never, ever, controlled our money. The manipulators of the US dollar, the Yen, the Yuan, the Euro, gold stocks, will always seem to beat us to the punch in policy steerage and money movement. Let's hope no Soros type gets a fancy to squeeze us for special extraction.

darthseditious:

23 Nov 2012 6:18:22pm

Actually gold is used a lot more than many people realise. It is not only used as computer connections but also in circuit boards as it is the perfect conductor. I don;t think there is one piece of high technology that doesn't use gold in some way or another. It's also one of the rarer metals which makes it valuable in itself, so your assertion, Magog, that it has no inherent value is wrong on quite a few levels.

Steve Mount:

I recall having a discussion / argument with a friend in the '90s who said 'Gold will never go above $300 an ounce. It has no intrinsic value'.

The Australian wine glut is most definitely not over yet, not by a long shot. One can still buy excellent quality wines at cleanskin prices, the likes of which were unheard of a decade ago. There will need to be a great reduction in plantings, and so harvest, before wine can be considered 'investement'.

Kevin:

23 Nov 2012 4:43:40pm

This gives increasing evidence for the need to put a tax on large amounts of dollar transfers, eg over $250,000. Brazil does it, and other countries do it. It reduces speculative exchange transfers and reduces the volatility of the currency.

Strangebrew:

23 Nov 2012 5:18:32pm

Money money honey honey. Girls love guys with money, it's good to be cashed up, 'specially if you been down n'empty for a bit. That's when you do love money, just after a scare and the sun is setting. Have thoughts for those upon which the sun is setting, the air becomes colder and the light fades. Soon the dark street highlights the situation, like a searchlight is switched on and hiding becomes necessary. Cashed up when it ends, hope and pray it ends. Then praise life when there is light and the stuffed thick wad of banknotes in your pocket allows stride and deep breathing. Retain deeply and long that feeling, for soon it no longer resonates if the wad becomes plural, and wallets bulge, ATM and accounts are full. Then life seems strangely emptier. Is it too easy then? Life has always had the poor and the rich, some say the gap is worldwide widening.

Fejjie:

David Nicholas:

23 Nov 2012 6:29:50pm

Well, Michael, what is the RBA waiting for?

Devalue the dollar and see if it does more harm than good. Business is choking, we are up against the ropes.

The news the other day that the IMF wants the AUD as a reserve currency suits them just fine. This was the worst news for us. I don't want the AUD as reserve currency, I want a trading currency we can use. We continue to allow the AUD to be the object of speculation and we die.

Australia is going under at the expense of looking good on the international currency exchanges. The RBA by not acting is acting recklessly. Doing nothing here is an active choice.

Bite the bullet, take the AUD down to 90 cents to the USD, boys and girls, and give Australian trade a chance. Do it now, every week we delay things it gets worse and given the way you people dither about interest rates, getting the mountain to come to Mohammed is easier than your obfuscation on this.

Steve Mount:

23 Nov 2012 6:46:06pm

And there's the rub on an open currency. The better it does, the more it appreciates in a global sense, and that very same appreciation then punishes the nation of that currency with an impetus to lower its value.

Surely not intended by financiers, I doubt that they'd understand the finesse, but that's an excellent example of a 'negative feedback loop'.

But what would I know, I'm a mere technical mortal, not a finance wizard.

cashedup:

23 Nov 2012 6:51:33pm

so who is actually buying all these oz dollars to push up its value? if its physically leaving the country then how is this possible when no one is allowed to move $10,000 dollars out with them on a plane?if its physically leaving the country place a gst on it 10% if its being bought in the country slap a tax on it if the other countrys run out of their stock slap a tax on itbut dont allow anyone to re sell the dollar with the tax built in but charge them a tax on selling the dollar.technically no other country can use the usa dollar outside of the states its illeagal. so do the same with the oz dollarmaybe for those who want to buy the oz dollar make them buy our gold instead.